UBS E-Mails Show Conflicts With Auction-Rate Clients

UBS AG was attempting to liquidate an $11 billion ``albatross'' of auction-rate bonds by selling the debt to individual investors as the market for the securities started to collapse, according to company e-mails.

While executives at the Zurich-based bank identified the hazards of auction-rate securities in August, they simultaneously began to ``mobilize the troops,'' holding more than a dozen conference calls with salesmen and giving them new marketing materials to promote the bonds, according to e-mails from David Shulman, the head of UBS's municipal securities group. ``The pressure is on to move inventory,'' he said in an Aug. 30 note.

The e-mails between Shulman and UBS executives were disclosed in a lawsuit filed yesterday by Massachusetts Secretary of State William Galvin, who claimed the bank committed fraud by selling the bonds as the equivalent of money market securities without disclosing to investors that the $330 billion market was lurching toward a breakdown. Investors who own the bonds now can't get their money.

UBS officials considered pulling out of the auction-rate market, where yields are set through periodic bidding, as early as September, five months before the company stopped supporting the programs, the e-mails show. The bank accumulated bonds by acting as a buyer of last resort to prevent auctions it managed from failing. Yields are set through auctions every seven, 28 or 35 days.

Demand Evaporates

``I have legal looking into options to exit some business lines,'' Shulman wrote on Sept. 6 to Panagiotis Koutsogiannis, a risk manager at the firm in London. ``We are looking into discounting the paper to distribute as well as potentially resigning from supporting as senior manager.''

Demand for auction-rate bonds evaporated last year as corporate cash managers stopped buying after an accounting ruling determined that they should be classified as long-term, not short-term, investments. Companies liquidated $70 billion of auction-rate securities in the last half of 2007, according to Chicago-based Treasury Strategies, which consults with companies on money management.

Investors, who viewed the securities as money-market instruments, also began to flee because much of the market was insured by companies facing losses from guaranteeing subprime mortgage-related debt.

Securities firms that supported the auctions for almost two decades abandoned the market in February, causing thousands of auctions to fail. Issuers such as the Port Authority of New York & New Jersey were left paying penalty rates as high as 20 percent and investors got stuck with bonds they couldn't sell.

SEC, State Probes

The U.S. Securities and Exchange Commission and at least nine state regulators are investigating how banks sold the bonds.

``Here you've got these e-mails, and that could give prosecutors a more favorable forum,'' said John Coffee, a Columbia University professor who specializes in corporate law.

Karina Byrne, a spokeswoman for UBS in New York, said in a statement yesterday the bank was ``disappointed'' with Galvin's complaint and ``will defend the specific allegations.''

Zurich-based UBS is cutting 5,500 jobs, shutting businesses at the investment-banking unit and trying to stem client defections after posting the highest net losses in the subprime crisis of any bank in the world. The U.S. Justice Department is also investigating whether it may have helped clients evade American taxes.

Increasing Risks

The bank sold $42 billion of auction-rate securities for municipalities and student loan corporations between 2002 and 2007, second to New York-based Citigroup Inc., according to data compiled by Thomson Reuters. The bank earned fees from underwriting and managing the auctions.

Galvin is seeking to force UBS to liquidate all the auction-rate bonds it sold to investors in Massachusetts, which he estimated totals $190 million. He is also probing Merrill Lynch & Co. and Bank of America Corp.

``The increasing risks that developed in 2007 were known to the financial services firms that sold them, but were not disclosed to investors who bought them,'' said J. Boyd Page, an attorney at Page Perry LLC in Atlanta specializing in securities fraud.

`Huge Albatross'

UBS's auction-rate holdings began to balloon last August, frequently topping a $2.1 billion-limit set by its risk management department, according to Galvin's investigation. Shulman, who is based in New York, was pressured to unload $1 billion as the firm looked to free up capital, the e-mails show.

``This is a huge albatross,'' Shulman wrote in an Oct. 31 e-mail, referring to the growing inventory. Shulman, who didn't return calls seeking comment yesterday, is 46 according to voter registration and campaign finance records obtained by Bloomberg News. He isn't personally being sued by Galvin.

UBS increased marketing efforts to individual investors in August. Financial managers were paid 40 percent of the marketing fee from the periodic auctions, according to e-mails.

Shulman sold his own auction-rate holdings last year, telling Galvin during a deposition that was released as part of the documents that his ``risk tolerance'' changed.

UBS managers and financial advisers in the wealth management division held 15 conference calls to discuss sales between Aug. 22 and Feb. 15, according to Galvin's investigation. When the market collapsed in February it was holding as much as $11 billion of the debt, the documents show.

``We need to move this paper and have to explore all angles possible,'' Shulman said in a Dec. 11 e-mail to Paul Wozniak, co-head of the student loan group at UBS. ``We need to do this as quickly as possible.''

U.S. Economy: Spending Rose More Than Anticipated

U.S. consumer spending rose more than forecast in May as tax rebates drove the biggest gain in incomes in almost three years, enabling households to at least temporarily overcome soaring fuel bills.

The 0.8 percent rise in purchases was the biggest since November, as Americans bought furniture, clothes and electronics after filling their autos' gas tanks, the Commerce Department said today in Washington. Incomes grew 1.9 percent, the most since September 2005, and measures of inflation were lower than anticipated.

The figures indicate that the fiscal stimulus will cause a pickup in economic growth this quarter after an expansion of 1 percent in the first three months of the year. The gains may not last, most economists predict, as rising unemployment and gasoline prices eviscerate consumer confidence. Sentiment among Americans fell in June to the lowest level since 1980, the Reuters/University of Michigan survey showed today.

``Consumers aren't fooled -- they know this is a temporary boost to their income,'' Ellen Zentner, an economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York, said in an interview with Bloomberg Television. Wages and salaries grew just 0.3 percent in May, the Commerce Department figures showed.

Treasuries were higher, with the benchmark 10-year note yielding 3.99 percent as of 11:29 a.m. in New York, down 4 basis points from yesterday. The Standard & Poor's 500 index was down 0.1 percent at 1,282.24.

`Holiday From Reality'

``This is the tax rebate that you're seeing here,'' Chris Low, chief economist at FTN Financial in New York, said in a Bloomberg Radio interview. ``It's a sense of hope, but it doesn't last. Call it a holiday from reality.''

Economists had forecast spending would rise 0.7 percent, according to the median of 72 estimates in a Bloomberg News survey. The spending estimate for April was revised up to 0.4 percent from an originally reported 0.2 percent increase.

Gross domestic product may increase about 2 percent in the second quarter, Low said, before shrinking in the final three months of the year. Economists at Morgan Stanley estimated the expansion may be 1.6 percent in April to June, up from a previous estimate of 0.8 percent.

The gain in income was almost five times larger than the median forecast of a 0.4 percent gain. Disposable income, or the money left over after taxes, surged 5.7 percent, the largest increase since May 1975.

Fed's Preference

The report also contained good news on inflation for Federal Reserve policy makers. The central bankers' preferred gauge of prices, which excludes food and fuel, increased 0.1 percent, compared with a 0.2 percent median estimate in the Bloomberg survey.

The price measure was up 2.1 percent from May 2007, also less than anticipated. Wages and salaries grew just 0.3 percent in May, the Commerce Department figures showed.

Adjusted for inflation, spending rose 0.4 percent, the biggest gain since December 2006.

Because the increase in spending was smaller than the gain in incomes, the savings rate jumped to 5 percent, the highest since March 1995, from 0.4 percent in April.

Fed policy makers this week kept the benchmark rate unchanged at 2 percent, ending a series of rate cuts, and said higher energy costs threatened to boost inflation. Still, they maintained a forecast that prices would ``moderate'' later this year, according to their statement.

`Diminished' Risk

Policy makers also said that ``although downside risks to growth remain, they appear to have diminished somewhat,'' partly as a result of ``some firming in household spending.''

A Commerce report earlier this month showed retail sales rose more than twice as much as forecast in May. Private surveys indicate the spending splurge continued this month as discounters, including Wal-Mart Stores Inc. and Costco Wholesale Corp., offered rebate-linked promotions.

About $48.1 billion worth of tax rebate checks were distributed in May and a total of $78.3 billion have gone out through today, according to the Treasury Department. Almost all of the tax rebates will be sent out by the second week of July, according to Treasury spokesman Andrew DeSouza.

There are signs the boost will not last. American Express Co. Chief Executive Officer Kenneth Chenault this week said credit indicators have deteriorated beyond the company's expectations.

Brunswick Woes

The rebates aren't large enough to benefit manufacturers like Brunswick Corp., the maker of Sea Ray yachts and Boston Whaler fishing boats. The Lake Forest, Illinois-based company said yesterday it plans to close four more North American plants and may fire as much as 10 percent of its workforce after U.S. powerboat sales fell to the lowest in more than 40 years.

Conditions in the energy, housing and labor markets ``continue to erode U.S. consumers' confidence and are reducing their ability and desire to purchase discretionary items,'' Chief Executive Officer Dustan McCoy said in a statement.

Record gasoline prices are also causing Americans to scale back travel plans. The number of travelers over the U.S. Fourth of July holiday will decline for the first time this decade, motoring group AAA said yesterday.

U.S. Stocks Drop, Dow Nears `Bear Market;' AIG, Merrill Fall

U.S. stocks fell, pushing the Dow Jones Industrial Average to the brink of a bear market, on concern subprime-related writedowns will worsen and record oil prices will reduce profits at consumer companies.

The Dow extended its retreat from an October closing record to almost 20 percent, the threshold for a so-called bear market. American International Group Inc. slid to an 11-year low on the insurer's plans to absorb as much as $5 billion of losses from units hit by writedowns. Merrill Lynch & Co. dropped to its lowest level since March 2003 after Lehman Brothers Holdings Inc. increased its second-quarter loss estimate. Micron Technology Inc., the largest U.S. producer of memory chips, plunged the most since February as falling prices weighed on earnings.

The Dow lost 121.16, or 1.1 percent, to 11,332.26 at 1:24 p.m. in New York. The 30-stock, down 10 percent this month in its worst June since 1930. The S&P 500 slid 8.77 points, or 0.7 percent, to 1,274.38. The index dropped 2.9 percent yesterday, the steepest decline since June 6. The Nasdaq Composite Index slipped 23.97 to 2,297.4. More than two stocks declined for each that rose on the New York Stock Exchange.

``This week the news on earnings is that the second quarter is probably going to be worse than we thought,'' said Ron Sweet, vice president of equity investments at USAA Investment Management Co., which oversees $100 billion in San Antonio. ``The old news keeps sticking around: it's energy prices, it's writeoffs at banks, it's the slow economy.''

The S&P 500 has fallen 3 percent this week, while the Dow has slid 4 percent and the Nasdaq tumbled 4.2 percent. The four consecutive weeks of declines for the S&P 500 is the index's longest losing streak since January. The S&P 500's 8.7 percent decline so far in June is the worst monthly performance since the 11 percent plunge in September 2002.

Earnings Slump

Analysts forecast earnings for companies in the S&P 500 will slump 11 percent on average, according to a Bloomberg survey today, compared with a projected decline of 8.9 percent a week ago. Goldman Sachs Group Inc. strategist David Kostin said in a report today that expectations for 2008 and 2009 profits are ``too optimistic'' and are likely to be reduced.

American International Group Inc. decreased 54 cents to $27.55. The world's largest insurer plans to absorb as much as $5 billion of losses for a dozen insurance units after their securities-lending accounts suffered $13 billion of writedowns tied to the subprime-mortgage collapse during the past year.

Merrill fell 41 cents to $32.64. Lehman analysts widened their second-quarter per-share loss estimate for the third- biggest U.S. securities firm to $2.78 from 64 cents, citing bigger-than-estimated writedowns related to the credit-rating downgrades of bond insurers.

Micron Slides

Micron slid 74 cents to $6.25 after posting a wider third- quarter loss as prices plunged for semiconductors used to store pictures and music in portable devices.

U.S. stocks tumbled yesterday as oil's $5-a-barrel surge, forecasts of more credit-market writedowns and a slowing economy threatened to extend a yearlong profit slump.

``The month of June has been difficult,'' Matthieu Bordeaux- Groult, who helps oversee about $6.2 billion as fund manager at Richelieu Finance in Paris, said in a Bloomberg Television interview. ``There are a lot of negative elements in the market such as high raw materials prices, but valuations are low and offer buying opportunities.''

The S&P 500, which has fallen 13 percent this year, is valued at 21.2 times earnings, near the lowest in two months.

LSE and Lehman team up on trading

The London Stock Exchange has announced the launch of a new pan-European equity trading platform in partnership with investment bank Lehman Brothers.

The LSE said the trading platform, named Baikal, would allow investors to trade shares in 14 European countries and enable them to keep their identities partially concealed.

The London Stock Exchange is facing growing pressure from transatlantic rival NYSE Euronext, which brings together stock markets in New York, Paris, Brussels, Amsterdam and Lisbon.

AdvertisementMost recently, the British company lost out in a race to buy a stake of the Doha stock exchange in the fast-growing and oil-rich Middle East region. NYSE Euronext said on Tuesday that it had agreed to buy 25% of the Doha stock exchange for €161m.

LSE and Lehman team up on trading

The London Stock Exchange has announced the launch of a new pan-European equity trading platform in partnership with investment bank Lehman Brothers.

The LSE said the trading platform, named Baikal, would allow investors to trade shares in 14 European countries and enable them to keep their identities partially concealed.

The London Stock Exchange is facing growing pressure from transatlantic rival NYSE Euronext, which brings together stock markets in New York, Paris, Brussels, Amsterdam and Lisbon.

AdvertisementMost recently, the British company lost out in a race to buy a stake of the Doha stock exchange in the fast-growing and oil-rich Middle East region. NYSE Euronext said on Tuesday that it had agreed to buy 25% of the Doha stock exchange for €161m.

Citigroup may write down $9 billion in Q2: Goldman Sachs

Citigroup Inc may incur second-quarter write-downs of $9 billion and raise additional capital, said a Goldman Sachs analyst, who widened his loss estimate for the bank for the period.

Goldman's William Tanona said he now assumes Merrill Lynch & Co Inc will incur $4.2 billion of write-downs in the second quarter. He widened his quarterly loss estimate on the world's largest brokerage to $2 a share from $0.25.

The analyst, who also added Citigroup to the Americas conviction sell list, expects the bank to post a loss of 75 cents a share for the quarter, compared with his prior forecast of a loss of 25 cents.

"We see multiple headwinds for Citigroup including additional write-downs, higher consumer provisions as a result of rapidly deteriorating consumer credit trends, and the potential for additional capital raises, dividend cuts, or asset sales," Tanona said.

Oil Drops More Than $2 After Supply Gains First Time in 6 Weeks

Crude oil fell more than $2 a barrel after record fuel prices cut consumption, causing U.S. inventories to rise for the first time in six weeks.

Stockpiles gained 803,000 barrels to 301.8 million last week, the Energy Department said. A 1.1 million-barrel drop was forecast by analysts in a Bloomberg News survey. Fuel demand averaged 20.2 million barrels a day in the past four weeks, down 2.3 percent from a year earlier, the report showed.

``There's no question that high prices are having an impact on driving patterns and gasoline demand,'' said Rick Mueller, director of oil practice at Energy Security Analysis Inc. in Wakefield, Massachusetts. ``We had a nice crude-oil build and the market is responding as it should.''

Crude oil for August delivery declined $2.45, or 1.8 percent, to settle at $134.55 a barrel at 3:11 p.m. on the New York Mercantile Exchange. Futures touched a record $139.89 on June 16.

Gasoline for July delivery fell 6.94 cents, or 2 percent, to settle at $3.3941 a gallon in New York. Futures reached a record $3.5762 a gallon on June 16.

Pump prices are closely tracking futures. Regular gasoline, averaged nationwide, fell 0.2 cent to $4.067 a gallon, AAA, the nation's largest motorist organization, said today on its Web site. Pump prices reached a record $4.08 a gallon on June 16.

Prices are also lower because the United Arab Emirates said it's ready to boost supplies, if needed. Saudi Arabia said on June 22 it would increase daily crude-oil output by 200,000 barrels to 9.7 million barrels next month. Saudi Arabia and the U.A.E. are the biggest and third-largest producers in the Organization of Petroleum Exporting Countries.

Interest Rates

Oil was unchanged from earlier trading after the Federal Reserve left its benchmark interest rate at 2 percent, ending the most aggressive series of rate cuts in two decades, as record energy prices threaten to increase inflation.

Futures have almost doubled over the past year as investors looking to hedge against the dollar's drop have purchased commodities, helping push oil, gold and corn to records. Rising Asian fuel consumption and falling output in the North Sea, Russia and Mexico have contributed to the rally.

Arjun N. Murti, the Goldman Sachs analyst who last month said oil may rise to $200 a barrel within two years, increased his forecasts, in a report dated June 18, because output is failing to match demand. U.S. benchmark West Texas Intermediate crude oil may average $118 a barrel this year and $140 a barrel next year, Goldman analysts led by Murti wrote in the report.

`New Fundamentals'

Daniel Yergin, chairman of Cambridge Energy Research Associates, told a congressional panel that oil prices are being driven by ``new fundamentals'' involving the merging of oil and financial markets. He added that the price of oil has hit a ``break point'' where the U.S. will begin to seek alternatives.

Gasoline demand has averaged 9.28 million barrels a day over the past four weeks, down 2.1 percent from the same period last year, the department said. Demand for distillate fuel, a category that includes heating oil and diesel, averaged 4.06 million barrels a day, down by 1.1 percent from a year earlier.

``In our view, 2007 may well have been the top, the break point, in terms of U.S. gasoline demand,'' Yergin said in prepared testimony to the Joint Economic Committee.

Consumption of gasoline in the U.S. increases during the summer, when Americans take to the highways for vacations.

``More attention is now being paid to the demand numbers, and they are having an impact on prices'' said Tim Evans, an energy analyst for Citi Futures Perspective in New York. ``Prices shrugged off weakening demand but it has probably gotten to a point where it can be ignored no longer.''

Oil supplies dropped 24.8 million barrels, or 7.6 percent, in the five weeks ended June 13.

Fuel Stockpiles

Gasoline stockpiles fell 153,000 barrels to 208.8 million barrels, the department said. Analysts surveyed before the report were split over whether supplies would rise or fall.

Distillate-fuel inventories rose 2.82 million barrels to 119.4 million barrels in the week ended June 20, the seventh- straight increase, the report showed. A 2 million-barrel gain was forecast. Stockpiles last week were 1.1 percent higher than the five-year average, the department said.

``The size of the distillate increase was a surprise and is also contributing to the downdraft in prices,'' Evans said.

Record energy prices have hit airline profits and are now threatening plane manufacturers. Boeing Co., the No. 2 commercial planemaker, fell the most in more than five years after Goldman Sachs Group Inc. cut its rating to ``sell'' on concern that surging fuel prices and a weakening economy will slow orders.

Boeing declined $5.15, or 6.9 percent, to $69.64 at 4:15 p.m. in New York Stock Exchange composite trading. It was the biggest drop since Aug. 13, 2002.

Brent crude oil for August settlement fell $2.13, or 1.6 percent, to settle at $134.33 a barrel on London's ICE Futures Europe exchange. Prices climbed to a record $139.32 on June 16.

Recession Will Drag U.S. Stocks Lower, Merrill Says

U.S. stock prices have further to fall because consumer spending is ``hobbled'' and record food and energy prices point to a worse-than-average economic recession, Merrill Lynch & Co. said.

The Standard & Poor's 500 Index has never tumbled to a low within the first three months of a contraction, said Brian Belski, Merrill's U.S. sector strategist. The 19-month low reached on March 10 was about 2 1/2 months into the current recession, according to David Rosenberg, Merrill's chief North American economist.

``This is not your average recession,'' New York-based Belski wrote in a report today. ``We would urge caution for investors attempting to call the bottom in the current environment.''

Increasing writedowns and dividend cuts from U.S. financial companies and record prices for oil, coal, fertilizer and rice signal that the U.S. economy is shrinking for the first time since 2001, Belski said. Gasoline prices have climbed to more than $4 a gallon nationwide after oil futures reached a high of $139.89 on June 16. The world's biggest banks and securities firms have lost almost $400 billion from asset writedowns and credit market declines tied to the U.S. subprime mortgage market collapse.

``Given that our economy has always relied heavily upon the consumer, we find it hard to believe that this will be an `average' recession when it appears that the consumer continues to weaken,'' Belski said.

The strategist said investors should ``not be fooled'' by the S&P 500's 12 percent gain between March 10 and May 19 because the advance doesn't indicate a turnaround in the economy. The stock benchmark has fallen 7.5 percent in the past five weeks.

Citigroup Readies More Job Cuts Under Pandit's Plan

Citigroup Inc. may begin another round of job reductions as soon as this week under a plan drawn up in March to cut the trading and investment-banking workforce by 10 percent, said a person with knowledge of the matter.

The largest U.S. bank has eliminated about half of the 6,000 jobs targeted since then, said the person, who declined to be identified because Citigroup hasn't disclosed the plans publicly. Citigroup employs more than 300,000 people worldwide and has announced about 13,000 job reductions this year.

Chief Executive Officer Vikram Pandit is lowering costs and shedding assets after the New York-based company reported two straight quarterly losses totaling a record $15 billion. The world's largest banks and brokerage firms have slashed more than 80,000 jobs since subprime mortgage defaults infected credit markets and led to almost $400 billion of writedowns and losses.

``I see more downsizing to come,'' said Andy Mantel, managing director of Pacific Sun Investment Management Ltd. in Hong Kong. ``Banks need to take precautionary measures.''

Mark Watson, a 22-year Citigroup veteran based in London, has decided to leave the bank, according to a memo sent to employees last week. He had been co-head of debt underwriting until November, when Citigroup combined its equity and debt underwriting units and the equity head, Tyler Dickson, was promoted to lead the larger group. Citigroup said Watson would ``work on transitional issues before taking a new position within the organization.''

Stock Decline

The shares fell 63 cents to $18.67 as of 11:43 a.m. in New York Stock Exchange composite trading. Citigroup has dropped 67 percent since reaching a record $56.41 in December 2006, the biggest decline since December 1991, when predecessor Citicorp fell 75 percent to $8.63 from the prior peak of $35.13 in October 1989.

The bank has disclosed plans to eliminate more jobs during the past year than any other financial institution, according to data compiled by Bloomberg. UBS AG, Lehman Brothers Holdings Inc. and Merrill Lynch & Co. are among companies that have disclosed more than 5,000 job reductions.

More than two dozen financial companies worldwide have announced plans to eliminate more than 83,000 jobs since last July, or about 3.3 percent of their employees. Following the dot- com bust in 2000, 17 percent of banking and securities in New York were wiped out, according to the Bureau of Labor Statistics.

`Re-Engineering' Effort

``Citi indicated earlier this year that it would be resizing this business in response to market conditions and as part of our ongoing re-engineering efforts,'' said Dan Noonan, a spokesman for the division, in a prepared statement.

The company probably will report a second-quarter loss of 40 cents a share after $8.7 billion of asset writedowns, UBS analyst Glenn Schorr said in a June 20 note to clients.

Schorr's prediction came after Chief Financial Officer Gary Crittenden forecast ``substantial'' additional writedowns and more losses on consumer loans. Citigroup's $42 billion of credit losses and writedowns since last year account for about 10 percent of the global total, according to Bloomberg data.

Citigroup has lost more than any company in the mortgage market rout and its shares tumbled 63 percent in the past year. Pandit, 51, was promoted in December to replace Charles O. ``Chuck'' Prince, who was ousted the previous month.

Securities Unit

Citigroup said in January it would eliminate about 4,000 jobs in the securities division, and said two months later that the number had increased by about 2,000. Citigroup then said in April it would slash 7,000 jobs outside the investment-banking group over the next year, and executives have said further reductions are likely.

The Wall Street Journal reported yesterday that employees may begin receiving termination notices this week.

Goldman Sachs Group Inc., the biggest U.S. securities firm, will get rid of as much as 10 percent of the jobs in its investment-banking division in one of the company's largest single rounds of headcount reductions this year, the Financial Times reported today, without citing anyone.

Goldman spokeswoman Connie Ling declined to comment on the reported job cuts.

Apollo's Leon Black Sued By Huntsman Over Abandoned Acquisition

Leon Black, founder of Apollo Management LP, was sued for more than $3 billion by Huntsman Corp., escalating the fight over his attempt to abandon a takeover of the chemicals maker.

Black and Apollo co-founder Joshua Harris engaged in fraud and tortious interference, Huntsman said in a complaint filed today in Texas state court in Montgomery County, north of Houston, where its management is based. The allegations stem from the company's decision in July to accept an offer from Apollo's Hexion Specialty Chemicals Inc. unit over a proposal by Basell Holdings NV.

Hexion sued Huntsman last week to terminate the $6.54 billion deal, saying the combined company would be insolvent. Today's complaint is an unusual step by Huntsman to personally drag Black and Harris into the dispute, the latest court battle over leveraged buyouts that have fallen apart, legal experts said.

``Pulling in the people behind the private equity shell is novel,'' Elizabeth Nowicki, a Tulane University Law School securities professor and a former attorney with the U.S. Securities and Exchange Commission. ``Those people are usually pretty well protected, but they won't sleep well tonight.''

The Apollo-Huntsman deal is one of the biggest uncompleted transactions announced prior to last year's credit-market collapse, which led to a tripling of borrowing costs and a slowing of the U.S. economy.

``Apollo did a deal it wishes it hadn't done and Huntsman really wants to do it,'' said Steve Kaplan, a professor at the University of Chicago Graduate School of Business who studies private equity. ``We're still working through the hangover from last year.''

Huntsman fell 9 cents to $12.75 at 12:23 p.m. in New York Stock Exchange composite trading. The stock dropped a record $8 after Apollo announced its lawsuit on June 19.

`Unfortunate'

``It is unfortunate that Huntsman has chosen to file a baseless lawsuit against Apollo and to personally sue two of its principals,'' Hexion said in an e-mailed statement. Hexion said the suit violates the merger agreement, which calls for any litigation to be filed in Delaware. Huntsman legal headquarters are in Salt Lake City.

Apollo convinced Huntsman to accept its offer for $28 a share instead of a rival bid from Basell, unit of Access Industries Holdings LLC.

``We went with Apollo based on the strength of the contract and the assurances of the principals, particularly Josh Harris,'' Huntsman Chief Executive Officer Peter Huntsman said today in an interview. ``We broke the Access deal and now it's very apparent to us that they didn't have any intention of closing at $28 a share.''

`Novel Strategy'

The legal strategy may open Apollo to paying more than the termination fee dictated by the merger agreement.

``Making tortious interference claims is a novel strategy in the context of big LBO deals that have fallen apart in the past few months,'' Tulane's Nowicki said. ``Huntsman is saying, We were lured away from doing a better deal through fraud.''

Black and Harris founded Apollo in 1990 after working at collapsed investment bank Drexel Burnham Lambert Inc. Apollo pursues investments in distressed assets such as leveraged loans and has undertaken leveraged buyouts of companies including Harrah's Entertainment Inc. and Realogy Corp.

The firm created what became closely held Hexion through a series of chemical industry acquisitions.

Chairman Jon Meade Huntsman, 71, founded Huntsman in 1970 as a container maker, creating Styrofoam ``clamshell'' boxes for McDonald Corp.'s Big Mac hamburgers in 1974. He built the company with debt-financed acquisitions over two decades, gaining products such as laundry detergent ingredients, paint pigment, and polyurethane foam for seat cushions.

Peter Huntsman, 45, the founder's son, took the company public in February 2005, raising $1.45 billion selling common shares for $23 each. The company has since acquired a textile- dye unit and shed businesses that make commodity polymers and chemicals. Utah Governor Jon M. Huntsman Jr. is the founder's other son.

Inflation Making a Comeback?

Inflation, the curse of the 1970s, is staging a comeback, led by sky-high oil prices. This time, the menace is more genuinely global than three decades ago, and this time much of it is "Made in China".

Wary of past errors, Western central banks may well opt for shock therapy -- interest rate rises -- in an effort to prevent prolonged stagflation, the toxic mix of inflation and economic stagnation that followed the oil crises of the 1970s.

Their prospects of success depend at least in part, though, on how willing the rising powers of the developing world are to play the game, above all China, an economy that was shut to the outside world 30 years ago but has now taken it by storm.

While inflation is far higher in faster-growing regions than in the United States and Western Europe, everyone feels the pain because of the globalization of trade, says Stephen Roach, Asia region chairman of Morgan Stanley.

"The risks of a new stagflation are mounting," he said in an article earlier this month. "Like nearly everything else in the world these days this one is likely to be made in Asia."

Average annual inflation rates in the developing world were about three times those of industrialized economies last year, and that overrun will widen in 2008, according to figures from the International Monetary Fund.

IMF forecasts, published last April and perhaps in need of upward revision, foresee world inflation rising from an average of 3.9 percent for 2007 to 4.7 percent in 2008. Revealingly, the IMF sees the inflation rate nearly doubling to just short of 12 percent in the emerging and developing world, as opposed to rising from 2.2 to 2.6 in advanced economies.

In rich and poor countries, fuel and food prices surges have sparked wave after wave of protests by truckers, taxi drivers, fishermen and farmers demanding government action, increasing fears of political instability and economic downturn.

The only solution, which is drastic, painful and risky, may be for the Group of Seven long-industrialized economies to raise their currency values further by raising interest rates, says Stephen King, chief economist at HSBC.

"We must be cruel to be kind," King says, suggesting what is needed is a "short, sharp, collective interest rate shock".

That would be a U-turn from Western appeals for currency appreciation in China and other emerging market economies to address global imbalances, King says.

But it would, he argues, put the focus on the source of the global inflation problem, overly lax monetary conditions in the emerging world.

This would force emerging market countries to confront the disconnect between their increasing economic maturity and their monetary youth and inexperience, he says.

The risks for the developed countries are the ones everyone is aware of -- that rate rises compound existing downturns in the United States and other countries already weakened by credit crunches or housing slumps, or both, notably Britain.

The underlying assumption is that the G7 countries take the lead and everyone else more or less follows, which for emerging market economies means abandoning cheap-currency policies that do little or nothing to combat inflation or overheating.

What's true for China and other Asian economies is even more so for Saudi Arabia and its oil-exporting neighbors in the Gulf region, where currency pegs to the dollar cause double-trouble, says Harvard economics professor Martin Feldstein.

Firstly, because of dollar-pegging, Saudi Arabia was forced to more or less match U.S. interest rate cuts recently when what it needed was the reverse to combat overheating in the economy.

Secondly, given that oil is paid for in dollars, weakness in the dollar exchange rate means the likes of Saudi Arabia end up "importing" inflation when they are forced to pay more for goods bought in foreign markets other than the United States.

"Emerging market countries around the world have been able to pursue successful anti-inflationary policies after abandoning their dollar pegs," Feldstein said in an article published last week.

NOT SO FAST, SAY SOME

Economists at Standard Chartered bank share the belief that China is now more the problem than the help it once was when it comes to keeping a lid on global inflation. Unlike HSBC's King, however, they suggest rapid rate rises might be foolish.

"Two wrongs don't make a right," the bank's economists wrote in a research report. "If central banks should have been tighter in recent high-growth years, that's not a reason to be tighter now in weaker growth times," the say.

So far at least, overall inflation is high in Europe and the United States but nothing like in the 1970s and nothing like in the emerging market countries now. Growth on the other hand is strong in emerging market countries and weak or weakening in the more mature economies.

The dollar's weakness and rising consumption in developing countries have driven fuel and food prices sharply higher. But there is little sign so far of the central banker's worst nightmare -- huge pay rises that cause a wage-price spiral -- materializing, at least in the industrialized world, say the Standard Chartered team.

They believe it is probably now time that companies took the hit instead of passing on the bill to consumers who are finding the pinch from food and fuel bills.

GLOBALISATION UNRAVELS?

In any case, the near-sevenfold rise in world oil prices in as many years appears to be triggering a rate of inflation in transport prices that will cost China as dearly as everyone else ultimately, judging by another research report.

Nowadays, it costs $8,000 to send a standard container by ship from Shanghai to the U.S. east coast, a four week trip that cost $3,000 back in the year 2000, according to economists at CIBC bank, Jeff Rubin and Benjamin Tal.

Faster ships have made the world a smaller place for trade in recent years but in the past 15 years increases in speed have doubled the amount of fuel needed to get goods to their destination.

"Globalization is reversible," say the economists, who estimated that soaring transport costs have wiped out the cost savings produced by the elimination of trade tariffs over the last 30 years.

The two oil crisis of the mid- and end-'70s were triggered by MidEast supply cuts, whereas the latest spike is largely attributed to soaring demand in countries such as China, whose rise as the factory of the world passed a turning point with membership of the World Trade Organisation in 2001, shortly before the latest upward trend in crude prices took hold.

Whatever the source of the latest crisis, an emergency meeting of oil producing and consuming countries at the weekend offered little prospect of a quick fix to record crude prices and the price of oil.

In the meantime, while the European Central Bank threatens to raise interest rates in the euro zone as early as next month, U.S. central bank chief Ben Bernanke may still be hoping he will not have to administer such tough medicine so fast to an economy battered by an unfinished housing slump.

When he graduated from Harvard university in 1975, world oil prices were soaring and U.S. inflation headed for 10 percent.

Cars were queuing up for fuel rations back then, but not now, Bernanke told Harvard graduates last week.

"The overall inflation rate has averaged 3-1/2 percent over the past four quarters, significantly higher than we would like but much less than the double-digit rates that inflation reached in the mid-1970s and again in 1980," he said.

Libya hires Goldman Sachs for advice on oil production

Libya, the holder of the largest oil reserves in Africa, hired Goldman Sachs Group to provide information on its behalf to credit rating companies, the first contract with a U.S. bank after the removal of sanctions.

"While there must have been some dealings between American and Libyan banks after the sanctions, this is the first contract given by Libya to a U.S. bank for works to be done on behalf of the government," Said Laswad, an economics professor at Tripoli's Al-Fateh University, said during an interview by telephone.

Shokri Ghanem, the chairman of state-run National Oil, met Wednesday with a Goldman Sachs delegation in Tripoli at the request of the North African nation's central bank.

"They wanted information on oil, gas production, revenue and other data," he said in a telephone interview from Tripoli.

Oil and natural gas account for more than half Libya's gross domestic product of $72 billion, according to the World Bank. Paul Kafka, a spokesman for Goldman Sachs in London, declined to comment on the contract with Libya.

The U.S. in 2004 began lifting two decades of diplomatic and economic sanctions after Muammar al-Qaddafi, Libya's leader since 1969, pledged to renounce terrorism and abandon efforts to acquire weapons of mass destruction.

The improvement in relations with the West enabled the Libyan government to attract more oil companies, including Exxon Mobil and Dutch Shell, to increase production and revenue to speed up work on roads, ports, schools and housing, which had been hampered by the sanctions.

Qaddafi also started to reduce state control of the economy and improve efficiency, selling stakes in banks to foreign lenders including Arab Bank and BNP Paribas. He increased the responsibilities of the central bank, which held last month its first open market operation.

The central bank on May 13 sold bonds for the first time in an effort to regulate credit supply. Local banks bought certificate of deposits worth 635 million dinars, or $530 million, maturing after 91 days, bearing an interest of 2.21 percent, according to the Central Bank's Web site.

"The Goldman Sachs team is tasked with negotiating with the credit rating institutions and giving them information about Libya," said National Oil on its Web site. "The action is in conformity with the global drive for more transparency."

Libya did not identify the credit rating companies that are seeking to rate its debt.

National Oil's Ghanem, who served previously as prime minister, in March said Libya's sovereign wealth fund will avoid buying assets in the U.S. because of politically motivated restrictions on investments by Arab states there.

Oil prices doubled in a year to a record $139.89 a barrel on June 16, allowing Libya to build a sovereign wealth fund that reached $100 billion by the end of 2007.

Libya, a nation of 6 million people that's larger than the U.S. state of Alaska, ranks third in oil production in Africa, behind Angola and Nigeria, with an output of 1.7 million barrels a day in May, according to Bloomberg estimates. It seeks to increase its production capacity to 2 million barrels a day this year and 3 million barrels day in 2012.

Bank of America's Bid Value for Countrywide Falls by $1 Billion

Bank of America Corp.'s offer for Countrywide Financial Corp., the biggest U.S. mortgage lender, has lost $1 billion or a quarter of its value since January as the housing slump points to additional losses for lenders.

After four months of falling share prices, Bank of America's stock swap is valued at $2.9 billion, compared with about $4 billion when the deal was announced on Jan. 11. While investors would get stock valued at $4.93 a share, Countrywide trades for 11 percent less. Investors are being scared off by weak home prices and legal risks, said Abigail Hooper, managing director of merger arbitrage hedge fund Havens Advisors.

Bank of America Chief Executive Officer Kenneth Lewis bailed out Countrywide after rising defaults and foreclosures left the Calabasas, California-based lender on the brink of bankruptcy. Bank of America said last month that it may not guarantee all of Countrywide's debt, increasing concern about a default. A federal investigation into lending practices could disclose more problems, said Hooper.

``If they were to find something that suggested fraud, this company could go into bankruptcy,'' Hooper said. ``Right now people in the arb community don't want to take that kind of risk.'' Hooper said her New York-based firm has a ``small position'' in Countrywide.

Bank of America, the second-biggest U.S. bank, fell $1.28, or 4.5 percent, to $27.09 at 1:25 p.m. on the New York Stock Exchange and has tumbled 34 percent this year. Countrywide, the largest U.S. home lender, dropped 24 cents to $4.43 and has slumped 51 percent.

The Deal

Under terms of the acquisition agreement, Countrywide holders would receive .1822 of a share of Bank of America stock in exchange for each Countrywide share. Countrywide investors are scheduled to vote on the deal on June 25.

Countrywide has racked up $2.5 billion in losses in the last three quarters as delinquent payments and home foreclosures escalated. That spilled over into the securities market, where the company has been forced to write down investments backed by home loans.

Late payments on Countrywide's loans jumped to 4.6 percent as of March 31, up from 3 percent in the previous quarter. Lewis said at a conference in New York last week that he still supports the deal because of Countrywide's technology, sales force and market share.

``I didn't anticipate the level of pain and political feedback that we've gotten but I still thing it's the right thing to do for the shareholder long-term,'' he said.

Bank of America, based in Charlotte, North Carolina, was the fifth-biggest mortgage lender in 2007, according to trade publication Inside Mortgage Finance. The company's spokesman, Scott Silvestri, referred to Lewis's remarks when asked to comment on the decline in the value of the deal.

Investigation

Countrywide is under federal investigation as to whether officials misrepresented the company's financial position and quality of its mortgages in regulatory filings, a person with knowledge of the probe said on March 8. In its first-quarter report, Countrywide said it has been told by the Justice Department that the Federal Bureau of Investigation can't confirm or deny whether a probe is being conducted.

``The investing public is slowly coming to the conclusion that this train wreck was just in the beginning stages,'' said Julian Mann, a mortgage and asset-backed bond manager at First Pacific Advisors LLC in Los Angeles, which manages $11 billion. ``If I was Ken Lewis, I might be reconsidering this deal. Obviously, the shareholders are not excited.''

More than 100 lenders have been forced to close, halt operations, or sell themselves since the beginning of last year amid the worst housing crisis since the Great Depression. The world's biggest banks and securities firms have reported more than $396 billion in asset writedowns and credit losses.

A call to Countrywide's media relations line wasn't returned.

Regulators Lay Plans for Investment Banks' Fed Access

U.S. regulators are planning how to let investment banks retain access to Federal Reserve loans if the central bank shuts an emergency program in September, two government officials said.

Federal Reserve Chairman Ben S. Bernanke, Treasury Secretary Henry Paulson and Securities and Exchange Commission Chairman Christopher Cox and their staffs are in almost daily discussions about the future of the so-called Primary Dealer Credit Facility, said one of the officials on condition of anonymity.

The Treasury and SEC want the program, designed to be in place until at least September, to be temporary. The discussions with the Fed center in part on what precautions might need to be in place in case a large securities company with hundreds of trading counterparties faces failure, as was the case with Bear Stearns Cos.

At the same time, any new rules would need to deter firms from becoming too dependent on Fed loans, addressing concerns that such aid might lead to more reckless lending and future financial crises.

``The question is: What is the appropriate quid-pro-quo for allowing access'' to the Fed, said Robert Eisenbeis, former head of research at the Atlanta Fed and now chief monetary economist at Cumberland Advisors Inc., a Vineland, New Jersey, investment firm. ``If the Fed is on the hook, they should have the responsibility'' to dictate capital and leverage ratios, he said.

Scope of Aid

Paulson today said it's ``imperative that market participants not have the expectations that lending from the Fed is readily available.'' He repeated his view, in a speech in Washington, that the Fed's powers should be expanded so it gets needed information from financial firms beyond commercial banks.

``We must limit the perception that some institutions are either too big or too interconnected to fail,'' Paulson said. ``If we are to do that credibly, we must address the reality that some are.''

The central bank said in March the PDCF would be in place ``for at least six months.'' By statute, the Fed can only lend to nonbanks in ``unusual and exigent circumstances.''

The Fed introduced the program March 16, the same day it agreed to lend against $30 billion of Bear Stearns collateral to secure its takeover by JPMorgan Chase & Co. Firms can borrow at the same rate as commercial banks, which are already subject to capital rules and direct oversight by the Fed.

Shutting Firms

The supervisors are discussing measures that can be implemented without action by Congress. One aspect -- setting up a mechanism to shut a failing firm in an orderly manner -- would probably require legislation.

Lawmakers plan hearings to consider measures strengthening oversight of investment banks. Senator Richard Shelby of Alabama, the senior Republican on the Senate Banking Committee, is skeptical of giving the Fed more powers.

Shelby ``believes the Congress should carefully consider whether an expansion of the Fed's authority is desirable,'' said Jonathan Graffeo, his spokesman.

Regulators haven't decided whether the Fed or SEC should be the main agency with power over capital and leverage, one official said. While the SEC has authority now, the arrangement failed to prevent the near-collapse of Bear Stearns in March.

Fed Deployment

Cox says the SEC succeeded in protecting Bear Stearns's clients. The Fed sent its own representatives to investment banks to monitor them after opening the PDCF.

Goldman Sachs Group Inc., Lehman Brothers Holdings Inc.,Merrill Lynch & Co. and Morgan Stanley now voluntarily submit their capital and liquidity positions to the SEC. The agency can restrict the firms' broker-dealer operations if they refuse to raise money or reduce leverage at its urging.

``The provision of backstop liquidity to the major investment banks has unavoidably reduced the penalties they face for taking on excessive risk,'' Cox wrote in an opinion piece in the Wall Street Journal today. ``Explicit legislative authorization for what is now a purely voluntary program of SEC supervision is vital.''

Some current and former Fed officials criticized the Fed's lending to Wall Street for creating moral hazard, or encouraging firms to take on more risk in anticipation of a rescue if their bets go wrong.

`Costly' Failure

Richmond Fed President Jeffrey Lacker urged that the central bank ``clearly'' set boundaries for its assistance. He warned in a June 4 interview that even new limits may not be believed by investors unless a financial firm fails ``in a costly way.''

``We run the risk of sowing the seeds of the next crisis,'' Philadelphia Fed President Charles Plosser told reporters after a June 5 speech in New York.

Investment banks had $8.4 billion of Fed loans outstanding on average in the week that ended June 11, down from a peak of $38.1 billion in April, the central bank's data show.

The Fed also started a $200 billion program for lending Treasuries to bond dealers. In December, officials introduced cash auctions to commercial banks to help ease funding strains.

``These facilities have played a significant role in easing liquidity strains in markets and we plan to leave them in place until conditions in money and credit markets have improved substantially,'' New York Fed President Timothy Geithner said in a June 9 speech.

Geithner, who spearheaded the Bear Stearns rescue, urged a regulatory overhaul so that one supervisor oversees the liquidity and capital of both commercial and investment banks.

``Either they will have to close the access and lock the door and throw away the key, or they will have to change the structure'' of supervision, said Edwin Truman, a former Treasury assistant secretary who is now a senior fellow at the Peterson Institute for International Economics in Washington. ``There is room for many views.''

Citigroup Shares Fall on Forecast for More Writedowns, Losses

Citigroup Inc., the bank that's lost more than any other in the collapse of the mortgage market, fell in New York trading after predicting ``substantial'' additional writedowns and more losses on consumer loans.

The company, whose value has dropped by a third this year, declined 4 percent on the New York Stock Exchange after Chief Financial Officer Gary Crittenden made the forecast in a conference call with investors.

Citigroup has booked more than $42 billion of credit losses and writedowns since last year because of the credit market contraction, or about 10 percent of the $396 billion racked up by banks worldwide. Vikram Pandit, who took over as chief executive officer in December, has raised $44 billion in capital and outlined plans for the company to reduce assets by $400 billion over the next two to three years.

``We will continue to have substantial additional marks on our subprime exposure this quarter,'' Crittenden said on the call, which was sponsored by Deutsche Bank AG. ``We may continue to see the magnitude of the marks decline, as the exposures that we have have declined.''

Citigroup, based in New York, fell 81 cents to $19.59 in composite trading at 2:13 p.m., after reaching $19.41 earlier today, the biggest decline among the top five U.S. banks.

Second-quarter markdowns related to subprime mortgages won't be as large as the $6 billion recorded for the first quarter, Crittenden said. Citigroup may also have to write down the value of assets backed by so-called monoline insurance companies such as Ambac Financial Group Inc., after they were stripped of their AAA credit ratings, the 54-year-old CFO said.

`Similar' Cost

Citigroup last quarter recorded a cost of $1.5 billion to account for the reduced likelihood that the insurers will be able to pay. The company may have a ``similar'' cost in the second quarter, Crittenden said.

``It is obviously another setback,'' said Marshall Front, who oversees $700 million as chief executive officer of Front Barnett Associates in Chicago, including Citigroup shares. ``The subprime issue is lasting longer than some had thought and may extend into 2009. It's difficult to know when we are going to see that begin to stabilize.''

Total credit costs, including loan write-offs and reserves for future losses, may exceed those reported for the first quarter, Crittenden said. The company had $5.6 billion of such costs in the first quarter, after a record $7.3 billion in the fourth quarter of last year, according to the firm's financial statements.

``This quarter will still have some of the same challenges that we had in the prior quarter, but it will also, I believe, represent sequential improvement over the prior quarter,'' Crittenden said. The bank expects to build reserves during 2008, particularly in its U.S. mortgage portfolio, he said.

Leveraged Loans

On leveraged loans, Crittenden said the bank expects writedowns to be smaller than the $3.1 billion of markdowns taken in the first quarter.

``The marks in this quarter are unlikely to be of that same magnitude, but again they are still sizable marks,'' he said.

Citigroup is making ``good'' progress in disposing of the $400 billion in assets targeted by Pandit, Crittenden said.

The company has also said it's looking to sell its German consumer lending unit, and ``there's a lot of interest from different parties,'' Crittenden said.

Oil Falls More Than $4 as China Announces Fuel Price Increase

Crude oil fell more than $4 a barrel on speculation demand will decline, after China said it will raise fuel prices starting tomorrow.

China, the second-biggest fuel consumer after the U.S., will increase gasoline and diesel prices by 1,000 yuan ($145.50) a ton, the National Development and Reform Commission said. The increases represent a 17 percent gain for gasoline and 18 percent for diesel. Gasoline, natural gas and heating oil also fell.

``The announcement of the Chinese fuel price increase sent the market sharply lower,'' said Michael Fitzpatrick, vice president for energy risk management at MF Global Ltd. in New York. ``This should have a big impact on demand.''

Crude oil for July delivery fell $4.81, or 3.5 percent, to $131.87 a barrel at the 2:30 p.m. close of floor trading on the New York Mercantile Exchange. Futures climbed to a record $139.89 on June 16. Prices are 91 percent higher than a year ago.

Brent crude oil for August settlement declined $4.24, or 3.1 percent, to $132.20 a barrel on London's ICE Futures Europe exchange. Prices climbed to a record $139.32 on June 16.

China will also raise jet-fuel prices by 1,500 yuan a ton, or 25 percent, tomorrow, the top policy planner said. On July 1, China will increase electricity prices by an average 0.025 yuan a kilowatt-hour, or 4.7 percent. China will impose temporary caps on thermo-coal prices until the end of this year.

The government is considering a so-called environmental tax, a new levy on auto fuels and changes to existing taxes on natural-resource use, Fu Jing, deputy director of policy and legislation at the State Administration of Taxation, said at the Energy Efficiency Asia conference in Beijing today.

Developing Countries

``The developing countries, in particular China, have been driving demand growth,'' said Eric Wittenauer, an analyst at Wachovia Securities in St. Louis. ``Subsidies and price caps insulate consumers from the full impact of higher prices. By rolling them back, some of the insulation is reduced and we can expect to see a demand response.''

Oil demand will fall 240,000 barrels to 48.71 million barrels a day among the 30-member Organization for Economic Cooperation and Development, the U.S. Energy Department said in a report on June 10. The OECD doesn't include developing countries such as China.

Chinese consumption is expected to rise 440,000 barrels to an average 8.02 million barrels a day this year, according to the report.

India, Malaysia, Indonesia and Taiwan have increased fuel prices and reduced subsidies this year, a move that may cut Asian demand and slow global oil-consumption growth.

Jeddah Meeting

Oil rallied for the first time in four days yesterday as President George W. Bush said he doesn't expect pledges of higher supplies to emerge from a June 22 meeting of producers and consumers in Jeddah, Saudi Arabia.

Saudi Arabia plans to increase crude-oil production by 200,000 barrels a day, according to a statement from the kingdom's embassy in London.

The statement didn't specify the timing of the increase. Oil Minister Ali Al-Naimi pledged on May 16 to boost output by 300,000 barrels a day in June. The country has since indicated it plans to announce a further addition at the Jeddah meeting.

Oil's volatility on a 10-day basis dropped by more than 17 percentage points today, according to data compiled by Bloomberg. Volatility is a measure of how far the price of a commodity deviates from average closing prices over a period of time, such as 10 or 30 days.

Oil futures traded in New York veered 38 percent from the 10-day average, as of 2:27 p.m. New York time. They strayed 63 percent from the average on June 13, the highest volatility since January 2007.

Gasoline Prices

Gasoline for July delivery fell 10.92 cents, or 3.2 percent, to $3.3575 a gallon in New York. Futures reached a record $3.5762 a gallon on June 16. Heating oil for July delivery dropped 14.68 cents, or 3.8 percent, to $3.7132 a gallon in New York.

The profit margin, or crack spread, for making three barrels of crude into one of heating oil and two of gasoline has dropped 21 percent in five days. The margin is $13.6084 today, the lowest since May 8, based on futures prices.

``Refiners aren't going to run at high rates because of these low margins,'' said Peter Beutel, president of energy consultant Cameron Hanover Inc. in New Canaan, Connecticut. ``We need to see these margins improve or we'll end up with higher diesel and gasoline prices.''

Natural gas in New York declined after an Energy Department report showed that U.S. inventories advanced 57 billion cubic feet to 1.943 trillion cubic feet last week. Analysts forecast an increase of 58 billion cubic feet, according to the median of 23 estimates compiled by Bloomberg News.

Natural gas for July delivery fell 34 cents, or 2.6 percent, to $12.87 per million British thermal units in New York. Futures are up 71 percent from a year ago.

Japan's Nikkei drops 2.2 percent

Japanese stocks dropped on Thursday as selling spread across the board on renewed concern over the health of the U.S. financial sector.

The benchmark Nikkei 225 index lost 322.65 points, or 2.2 percent, to 14,130.17.

'Investors dumped shares on fresh worries over the U.S. financial sector,' said Kazuki Miyazawa, market analyst at Daiwa Securities SMBC Co. Ltd.

Sentiment was downbeat as Morgan Stanley on Wednesday reported a slightly better-than-expected fiscal second-quarter profit. Earnings at the second-largest U.S. investment bank were still down 61 percent from a year earlier on declining revenue, prompting investors to sell banking shares.

'Investors were worried financial woes would spread from top U.S. banks to local, regional banks,' Miyazawa said, adding Wednesday's tumble on Wall Street and uncertainty over volatile oil prices also pressured the Japanese market.

Among losers, financial giant Mizuho Financial Group Inc. dropped 3.7 percent to 549,000 yen and its rival Mitsubishi UFJ Financial Group. lost 3.6 percent to 1,038 yen.

Japan's top automaker Toyota Motor Corp. fell 3.2 percent to 5,490 yen and Honda Motor Co. was down 3.4 percent at 3,700 yen.

Sony Corp. declined 2.6 percent to 5,220 yen. Japan Airlines Corp. lost 0.9 percent to 227 yen after pilots of the country's largest carrier launched a strike Thursday, forcing the cancellation of 34 domestic flights.

The Topix index of all Tokyo Stock Exchange First Section issues dropped 34.04 points, or 2.4 percent, to 1,375.60.

In currency trading, the dollar stood at 107.59 yen mid-afternoon in Tokyo, down from 107.83 yen in New York late Wednesday.

The euro stood at $1.5562 mid-afternoon in Tokyo, little changed from $1.5546 in New York late Wednesday.

The greenback stood at 1.3683 Singapore dollars, and 33.00 Thai baht.

Ex-Fund Managers at Bear Stearns Face Indictment

A New York City grand jury is expected to return sealed indictments Wednesday against two former Bear Stearns hedge fund managers in connection with the mortgage crisis, officials close to the investigation told NPR.

Ralph Cioffi and Matthew Tannin are expected to be charged with securities fraud in indictments that are scheduled to be unsealed Thursday. They are the highest level Wall Street executives to be charged in connection with the mortgage crisis so far.

As first reported by NPR, prosecutors allege the men told investors that two of their funds were in good shape, while privately telling colleagues they were worried about the funds' prospects.

The funds had a high level of exposure to bonds backed by subprime mortgages and both eventually collapsed. Investors lost about $1.6 billion.

The collapse of the hedge funds in June 2007 — coupled with questions about Bear Stearns management and oversight — lead to a run on the firm, which was eventually rescued by J.P. Morgan Chase.The firm underwent a severe liquidity crisis and was absorbed into JPMC at firesale prices. It also led investors to question how big firms were valuing their mortgage-backed securities.

The U.S. Attorney's office in New York declined to comment on the case, as did the FBI and defense attorneys for Cioffi and Tannin. Cioffi and Tannin are expected to either surrender to the FBI or be arrested Thursday.

FBI Arrests Hundreds In Mortgage Fraud Case

The FBI said Thursday that it has arrested more than 400 real estate brokers since March -- including dozens over the last two days -- in its crackdown on incidents of mortgage fraud that have contributed to the country's housing crisis.

One law enforcement official put the losses to homeowners and other borrowers who were victims in the schemes at more than $1 billion.

The Justice Department and FBI announced the recent arrests at a news conference Thursday afternoon in Washington. Apprehensions were made in Chicago, Atlanta, Miami and suburban Maryland.

"Operation Malicious Mortgage" resulted in 144 mortgage fraud cases in which 406 defendants were charged. On Wednesday, 60 arrests were made in mortgage fraud-related cases in 15 districts. Charges were brought in every region of the United States and in more than 50 judicial districts by U.S. Attorneys’ offices based upon the law enforcement and investigative efforts of participating law enforcement agencies.

"Mortgage fraud and related securities fraud pose a significant threat to our economy, to the stability of our nation's housing market and to the peace of mind of millions of American homeowners," said Deputy Attorney General Mark R. Filip. "'Operation Malicious Mortgage' and our other mortgage-related enforcement actions demonstrate the Justice Department’s commitment and determination to combat these criminal schemes, hold their perpetrators accountable and help restore stability and confidence in our housing and credit markets."

FBI Director Robert Mueller said that the FBI will continue to direct resources to prosecuting mortgage fraud.

"This operation is an example of our unified commitment to address this significant crime problem," Mueller said. "The FBI will continue to direct investigative and analytic resources towards mortgage fraud and corporate securities fraud that threaten our nation's economy."

Also a part of the operation was the indictment of two former Bear Stearns managers in New York, becoming the first executives to face criminal charges related to the collapse of the subprime mortgage market.

Ralph Cioffi and Matthew Tannin, who have been the target of a probe by Brooklyn federal prosecutors, are suspected of misleading investors about the risky market.

Houston Arrests

A group of Houstonians are accused of defrauding banks and stealing $24 million in a fraudulent mortgage scam, KPRC-TV in Houston reported.

Six defendants are suspected of recruiting people with good credit to act as buyers in fraudulent mortgage deals, prosecutors said.

Federal agents began making arrests early Wednesday morning, delivering defendants to the federal courthouse who are alleged to have operated the massive mortgage fraud ring.

Officials said they were identified as mortgage loan officers or straw buyers who defrauded lenders of $24 million. The defendants were charged with conspiracy, fraud and money laundering.

Named in the indictment were Latasha Bellow, Frankthea Williams, Ishmael Laryea, Charles Joseph Deshawn Wilson, Kristen Way and Robert Stanley.

The indictment alleges phony buyers were recruited to apply for loans to buy pricey condominiums in Houston and surrounding suburbs. The loan applications allegedly used fraudulent information to obtain millions of dollars that the defendants then pocketed, the indictment said.

Attorney Ed O'Suji represents Williams.

"She's not guilty. She's been in real estate for the last five to six years. This is something she makes a living off of like any other real estate agent or broker," O'Suji said.

Williams and two other defendants made federal court appearances Wednesday. Their bond was set at $50,000.

The remaining three were scheduled to appear in court on Thursday.

Kuwait Says Oil Over $100 Is Too High; Support Saudis

Kuwait followed Saudi Arabia in saying crude oil prices are too high as evidence mounts that energy costs are restraining growth and accelerating inflation.

``I think it's high,'' Kuwait Finance Minister Mustafa Al- Shimali said in an interview in Isfahan, Iran, today. A reasonable oil price would be ``more or less $100,'' he said.

Crude oil for July delivery fell 50 cents to $134.11 a barrel on the New York Mercantile Exchange at 10:59 a.m., after touching a record $139.89 yesterday.

Saudi Arabia, the world's largest oil exporter, has said the surging price of the commodity is ``unjustified'' and will host a meeting of producers and consumers in the coastal city of Jeddah on June 22 to help stabilize prices. Saudi Arabia will increase oil output by 200,000 barrels a day next month, King Abdullah told United Nations Secretary-General Ban Ki-Moon on June 15, according to a UN spokesman.

Oil prices fell 2.7 percent last week as Saudi Oil Minister Ali al-Naimi began to organize the meeting between producers, major industrial consuming nations and banks. State-owned Saudi Aramco said June 13 that it would start pumping oil from its 500,000 barrel-a-day Khursaniyah field within a month, a project that's been delayed since December.

``I would like to see these prices go down and in parallel also have the price of goods we import go down,'' Kuwait's al- Shimali said.

Kuwait's Inflation

Kuwaiti inflation accelerated to a record 10.1 percent in February as the cost of housing soared. Inflation rates have risen above 10 percent in five of the six Gulf Cooperation states, including Saudi Arabia and the United Arab Emirates, this year.

Kuwait pumped 2.59 million barrels a day last month, according to Bloomberg estimates, trailing behind Saudi Arabia, Iran and the United Arab Emirates. Saudi Arabia said it will produce 9.7 million barrels of crude a day next month, according to the UN's Ki-Moon. That represents a 450,000 barrel-a-day increase from the amount it pumped during May, according to Bloomberg estimates.

The Organization of Petroleum Exporting Countries doesn't have an official price target for crude oil, though officials from the group's 13 member nations have repeatedly said prices are too high. The group kept official production quotas steady at its last three meetings in December, February and March.

Iran, OPEC's second-largest producer, objects to an increase by Saudi Arabia without prior consultation with other OPEC members.

Iran's Objections

``Any increase in oil production should be validated in this body's ministerial meeting,'' Iran's OPEC governor, Mohammad Ali Khatibi, said on the state television Web site. ``If Saudi Arabia undertakes to raise output unilaterally, it will be a wrong action.''

The Jeddah meeting will be attended by energy ministers from producing nations, including Kuwait's Mohammed Al-Olaim, as well as representatives from importing countries, such as U.S. Energy Secretary Samuel Bodman, German Economy Minister Michael Glos and French Energy and Environment Minister Jean-Louis Borloo.

``It is apparent that in this meeting, consumers will talk about the increase of oil production rather than other issues, while producers believe that there is no shortage in the oil market,'' Iran's Khatibi said.

OPEC President Chakib Khelil, speaking in a June 12 interview in Algiers, ruled out the possibility of an official production increase from OPEC before the group's next meeting in September, rejecting U.S. arguments that supply and demand, rather than speculation, is behind the surge in prices.

Oil futures prices averaged over 200 days surpassed $100 a barrel for the first time today on the New York Mercantile Exchange, an indication of the durability of a rally threatening global economic growth. The so-called 200-day moving average indicator crossed $70 on Nov. 7, $80 on Feb. 8 and $90 on April 23.

Morgan, Citi Lose Oil Analysts as Hedge Funds Hire

Wall Street is losing its top oil analysts as securities firms suffer record losses and hedge funds offer the promise of higher pay.

Morgan Stanley's Douglas Terreson and Citigroup Inc.'s Doug Leggate, ranked first and second by Institutional Investor on coverage of the biggest oil companies, left their positions, the banks said. Geoff Kieburtz, the No. 3 analyst for oilfield contractors, is leaving Citigroup. Robert Morris, the top-ranked analyst for independent oil companies such as Anadarko Petroleum Corp., left Bank of America earlier this year.

Exxon Mobil Corp., Anadarko and other oil stocks rose to all-time highs this year as crude futures surged 46 percent to a record $139.89 a barrel and natural gas jumped 73 percent. The exits also came as banks and securities firms cut more than 83,000 jobs after the collapse of the subprime mortgage market led to $390 billion in writedowns and losses.

``Energy's been a hot area and you're getting some big turnover,'' said James Halloran, who helps oversee $38 billion in assets at National City Private Client Group in Cleveland. ``A lot of this has to do with Wall Street either not paying the same rate, or not being the same place, to be as fun anymore.''

Morgan Stanley dropped coverage of the three largest U.S. oil companies -- Exxon Mobil, Chevron Corp. and ConocoPhillips - - on June 4, after Terreson left, bank spokeswoman Jennifer Sala said last week. New York-based Citigroup, the largest U.S. bank by assets, got notice from Leggate on May 30.

Citigroup Defections

In a May 14 memo, Jonathan Rosenzweig, director of Americas research for Citi Investment Research, told employees Kieburtz was leaving to ``pursue another opportunity.'' Citigroup spokesman Duncan Smith confirmed the contents of the memo.

Faisel Khan, who covers refiners and gas-related companies, will take over Leggate's coverage, while Citigroup's oilfield- services coverage ``will be discontinued temporarily'' after Kieburtz leaves later this month, according the memo.

Leggate, 41, said he left on May 31 to join hedge fund Quadrum Capital Management in New York. Terreson, 46, and Kieburtz couldn't be reached for comment. Kieburtz will start his new job July 1 at Connecticut brokerage Weeden & Co., said Tom Orr, Weeden's head of research. The firm also hired former Bear Stearns Cos. analyst Ellen Hannan, he said.

JPMorgan

JPMorgan Chase & Co.'s head of commodities research, Katherine Spector, left the firm, spokeswoman Lauren Francis said, without saying when that happened or where Spector went. Lawrence Eagles of the International Energy Agency will fill the role in September, JPMorgan said on June 5.

Going from a securities firm to a hedge fund could mean doubling annual compensation to as much as $4 million because analysts often share in a percentage of earnings from their recommendations, said Alan Johnson, managing director for New York consulting firm Johnson Associates.

``Particularly if you're in a white-hot sector like energy, you can make a lot more money,'' Johnson said. ``If you've been around, you know these things are cyclical, and if you wait another year or two, the opportunity may pass you by.''

The losses reflect the increased value of energy analysis to hedge funds and mutual funds, said Ted Harper, who helps manage $9 billion at Frost Investment Advisors in Houston.

Spitzer Settlements

The Sarbanes-Oxley Act, passed by Congress in 2002, increased penalties for corporate wrongdoing and stiffened audit rules following the collapses of Enron Corp. and WorldCom Inc. The following year, former New York Attorney General Eliot Spitzer extracted $1.4 billion in settlements from 10 securities firms that he accused of using research to win investment banking business.

``The sell-side model prior to 2000 is not holding up,'' Harper said. ``You don't have the means by which to really underwrite a successful sell-side operation. As a result, they're no longer able to pay the salaries to attract the top talent.''

New York-based Morgan Stanley, the second-largest U.S. securities firm, plans to replace Terreson, spokeswoman Sala said. Lloyd Byrne, an analyst who covers independent oil and gas producers, also is leaving, she said. Stephen Richardson, who assisted Byrne, will take over coverage.

The departures mean less information will be disseminated to investors and more will be locked up in hedge funds, said James Wicklund, who left an analyst job at Bank of America in early 2007 and later joined hedge-fund firm Carlson Capital.

`Art and Intuition'

``You're losing the art and intuition of the business,'' Wicklund said. ``If this whole business was as easy as running an Excel model and coming up with an answer, then we'd all be making lots of money.''

Credit Suisse Group AG is losing Houston oilfield-services analyst Ken Sill. Sill, 46, said he's taking a buy-side position at a local firm after the bank decided to move its Houston research operation to New York.

``Research on the Street is going the way of the dodo,'' National City's Halloran said. ``The Street is going to have to figure out a method to keep the good guys around and paying for them or it's going to die out.''

Goldman Agrees on $7 Billion Cheyne SIV Restructuring

Goldman Sachs Group Inc. and Deloitte & Touche LLP agreed to auction some assets of a $7 billion structured investment vehicle set up by hedge fund Cheyne Capital Management (UK) LLP, in a model that may be used to wind down similar credit funds.

Deloitte, the accounting firm that is acting as receiver, will sell a portion of the assets of SIV Portfolio Plc, previously known as Cheyne Finance Plc, said Neville Kahn, a receiver at Deloitte in London. The auction will set the price at which any unsold debt would be transferred to a new company set up by Goldman, which will then issue notes backed by the assets, Kahn said.

``It's expected that other SIV restructurings will follow this model,'' Kahn said in an interview today.

Deloitte has been trying to reorganize Cheyne Finance since September after the SIV was shut out of the commercial paper market and forced to sell assets at a loss. SIVs with at least $31 billion of debt defaulted in the past 11 months, according to S&P.

SIVs, which use short-term and medium-term borrowings to buy high-yielding securities, owned more than by more $400 billion of assets at their peak last year. Investors shunned their debt amid concern that they held mortgage-linked assets that were losing value and they would be forced into fire sales because of financing strategies.

The threat of forced sales further roiling credit markets prompted U.S. Treasury Secretary Henry Paulson to start talks on setting up an $80 billion bailout fund last year. Citigroup Inc., Bank of America Corp. and JPMorgan Chase & Co. abandoned the so-called SuperSIV after banks began rescuing their own funds, led by London-based HSBC Holdings Plc.

Asset Auction

Almost half of Cheyne Finance's underlying assets were linked to U.S. residential mortgage backed securities, Moody's Investors Service said in an October 2007 report. Seven percent of the SIV's assets included collateralized debt obligations of asset-backed securities.

Deloitte's Kahn declined to comment on the SIV's assets.

Deloitte said in December that it agreed to initial terms for selling the Cheyne SIV's assets to Goldman Sachs as part of a restructuring. The auction will take place in the two weeks to July 18, Kahn said.

Deloitte is also the receiver to Golden Key, a $1.5 billion defaulted SIV set up by Geneva-based hedge fund manager Avendis Group, and is overseeing the wind-down of Whistlejacket Capital Ltd., a $7 billion SIV set up by London-based bank Standard Chartered Plc, and IKB Deutsche Industriebank AG's Rhinebridge Plc. Deloitte reached agreement with Goldman Sachs to restructure Golden Key in May.

``We are pleased that Goldman and Deloittes now appear to have got this deal done,'' London-based Cheyne said in an e- mailed statement earlier today.

Fear Still Infuses Lehman's Options

THE IMPLIED VOLATILITY of Lehman Brothers Holdings (ticker: LEH) options collapsed this morning in response to a second-quarter financial report that did not contain any surprises beyond the $2.8 billion loss announced last week.

In the absence of additional bad news, the implied volatility of Lehman's options traded to a low of about 73%, and edged higher to about 83%. These volatilities are markedly lower from the 120% or so levels on Friday, and are still almost twice as high as the financial sector.

Anyone watching Lehman's options during the company's conference call to discuss the second quarter would have seen options volatilities rising and flowing in response to management statements and stock analyst questions. Lehman's options volatilities may lose some sensitivity if Goldman Sachs (GS) and Morgan Stanley (MS) do not introduce negative surprises during their earnings reports that will be released Tuesday, and Wednesday, respectively.

The fear that is still priced into Lehman's options is a reminder that expensive options tend to remain expensive for longer than expected; the same is true for cheap options.


This chart shows Lehman's implied volatility and historic volatility during the past 30 days.

The conference call that Lehman hosted to discuss the second quarter seems to have done little to persuade investors to change their opinion on the stock. Some stock investors think Lehman's shares should rise since it trades at a discount to its $34 book value, and other investors do not.

The consensus in the options market appears to be that Lehman's stock is "dead money" and not likely to advance as the investment bank arguably sacrificed its earnings power to stabilize the firm against the deleterious effect of soured positions.


This chart shows Lehman's stock price since July 2007.

With Lehman's stock price up about 3% at almost $27 -- due most likely to short covering -- options trading suggests bearish speculators are readjusting bearish June put positions that would have increased in value if Lehman's stock plunged lower in response to the quarterly financial report. This is why there is so much trading volume in Lehman's June 15, 17.50, 20, and 22.50 puts, and then also in corresponding July options.

The July 30 calls are very active, but don't interpret that as a sign that investors expect the stock will soon trade above $30, or that anyone is establishing positions in Lehman that would increase in value if Goldman's earnings news lifts the sector. Lehman's July 30 call trading shows investors are readying for the stock to remain somewhat comatose. Investors have been selling July 30 calls almost since the stock market opened, effectively betting against the 7% advance that Lehman's stock logged when financial results were released.

The tell-tale options trade thus far is the buying activity in Lehman's October 25 puts. Almost 3,000 of these puts traded, suggesting that some bearish investors will lie in wait for Lehman's next quarterly financial report. They have bought these puts because they think Lehman's stock will decline.

Lehman's new management team did their best to allay investor concern during the conference call, and to defend their business model, but the message from the options market is that the fear ain't over till it's over.

Goldman completes $7 billion SIV restructure

Goldman Sachs Group Inc (GS.N) has completed a long-awaited rescue of a $7 billion structured investment vehicle, the receivers said on Tuesday, paving the way to clear up more troubled mortgage assets.

The deal to restructure the SIV, formerly run by British hedge fund Cheyne Capital, comes as Wall Street's biggest investment bank beat expectations by avoiding major losses on assets, though quarterly earnings dropped by 11 percent.

"We are delighted ... we are in a position to sign a restructuring agreement in respect of the Cheyne Finance portfolio today," said Neville Kahn, of accountancy firm Deloitte and Touche LLP (DLTE.UL), who act as receivers.

Under the restructuring, Deloitte will price the assets in the market, selling a minority part of the portfolio to the group of creditors who want to cash out, the parties involved said in an official statement.

That will allow Deloitte to sell the rest of the assets to the remaining creditors -- who have already agreed to reinvest that money in a newly established vehicle set up by Goldman Sachs -- which will hold the rest of the portfolio.

The sale of the securities is expected to be completed on or about July 17, Deloitte said in the statement.

Other SIVs, including Golden Key, Whistlejacket and Rhinebridge, are expected to follow Cheyne's model, being restructured by Goldman, said Stephen Peppiatt, at Bingham McCutchen, a legal advisor to a Cheyne senior creditor.

"We thought that Cheyne would be restructured some time ago, it has taken longer, but now there is a template that others will follow," Peppiat said.

The Cheyne Capital SIV collapsed last year as the credit crunch hurt the value of its investments in asset-backed securities and collateralized debt obligations (CDOs).

JOB CUTS

Goldman Sachs laid off hundreds of investment bankers last week, people familiar with the situation and recruiters told Reuters on Monday, with one insider saying 25 percent of employees at the vice-president level were let go.

The cuts were seen as a reaction to slowing markets and a slump in merger activity in the wake of the credit crisis.

Yet finalization of the restructuring deal, which was first announced in December, provides a glimmer of hope for the revival of the market in troubled mortgage assets that are at the core of the global credit crisis.

"The good news is that we are capable of valuing these assets and that we can move on from this phase to the next one," said Jeroen van den Broek, a credit strategist at ING.

SIVs ran into trouble last August when liquidity in the credit markets dried up, preventing them from raising funds and also causing the value of their assets -- mainly bank debt and asset-backed securities -- to drop.

SIVs, held by banks, hedge funds or other institutions, issue a mixture of short-term debt and capital to buy longer-term assets, which pay more interest than the amount they pay on their notes.

List Of Highest-Paid CEOs In 2007

The list of the 10 highest-paid CEOs for 2007 at Standard & Poor's 500 companies is based on calculations by The Associated Press.

The total pay figures are rounded and are based on the AP's compensation formula, which adds up salary, perks, bonuses, above-market interest on pay set aside for later, and company estimates for the value of stock options and stock awards on the day they were granted last year.

1. John Thain, Merrill Lynch, $83.1 million
2. Leslie Moonves, CBS Corp., $67.6 million
3. Richard Adkerson, Freeport-McMoran Copper & Gold Inc., $65.3
million
4. Bob Simpson, XTO Energy Inc., $56.6 million
5. Lloyd Blankfein, Goldman Sachs Group Inc., $53.9 million
6. Kenneth Chenault, American Express Co., $51.7 million
7. Eugene Isenberg, Nabors Industries Ltd., $44.6 million
8. John Mack, Morgan Stanley, $41.7 million
9. Glenn Murphy, Gap Inc., $39.1 million
10. Ray Irani, Occidental Petroleum Corp., $34.2 million

Fed's Lacker Says Risks to U.S. Economy `Diminished'

Richmond Federal Reserve Bank President Jeffrey Lacker said downside risks to growth have ``diminished'' and reversing previous interest rate cuts makes ``eminent sense'' as the economy recovers.

While the danger of a more rapid slowing in growth ``has not entirely disappeared, my sense is that such downside risks have diminished appreciably,'' Lacker said today in a speech in Spartanburg, South Carolina. ``And just as easing policy aggressively in response to emerging downside risks made sense, withdrawing some of that stimulus as those risks diminish makes eminent sense as well.''

Comments by Fed officials this month have led traders to increase bets the central bank will start lifting the main interest rate later this year to keep rising food and energy prices from fueling an increase in other prices, as well as demands for higher wages.

Lacker said the economy is growing at a ``tepid pace overall'' hindered by weak housing markets. ``Even if housing market activity does manage to bottom out later this year, it is likely that any recovery would be exceedingly slow,'' Lacker said.

The Federal Open Market Committee cut the benchmark lending rate 2.25 percentage points from January to April, the fastest easing in two decades, to cushion the economy from the worst housing recession in a quarter century.

The consumer price index rose 0.6 percent in May, the most since November. Prices climbed 4.2 percent in the 12 months to May, and 2.3 percent minus food and energy, the Labor Department reported last week.

`Unacceptably High'

``The latest figures confirm that inflation is unacceptably high,'' Lacker said. ``We need to be attuned to the risk that we emerge from the slowdown with inflation following a higher trend than when we went in.''

Fed officials are concerned the rise in prices could become embedded in public expectations and thereby accelerate inflation. The public's outlook for annual inflation over five years stood at 3.4 percent in June, up from 2.9 percent the same month a year earlier, according to the Reuters/University of Michigan Survey.

Maintaining inflation credibility ``depends on continuing to conduct policy in a way that is consistent with the stability of inflation expectations, and acting forcefully should those expectations erode.''

Fed Chairman Ben S. Bernanke said the FOMC ``will strongly resist an erosion in longer-term inflation expectations'' in a June 9 speech.

Quarter-Point Increase

Fed officials next meet June 24-25, when they plan to vote on interest rates and discuss their forecasts for growth, employment and inflation. Federal funds futures markets now show a 20 percent probability of a quarter-point increase this month in the policy rate, up from zero a month ago. The federal funds rate is now at 2 percent.

The economy grew 0.9 percent in the first quarter, the Commerce Department reported last month, the second three-month period of annualized growth rates below one percent. Private- sector employers have cut payrolls for six consecutive months, helping push the U.S. unemployment rate up to 5.5 percent in May, the highest in almost four years.

Lacker Dissented

The Richmond Fed has a tradition of favoring low rates of inflation and a constrained role for the central bank in monetary policy and discount window lending. Lacker has said he wants the Fed to announce a numeric goal for inflation rather than leave that goal ambiguous.

Lacker dissented in favor of higher interest rates in his last four meetings as an FOMC voting member in 2006. He returns as a voting member next year.

The Richmond Fed president recently warned against providing backstop financing to non-bank financial institutions facing fundamental credit problems. The Fed Board in Washington opened a separate discount window for primary government bond dealers on March 16 to increase liquidity.

``Establishing a new set of boundaries for central-bank lending is a high priority,'' Lacker, 52, said June 5 in an interview. ``You would expect that'' the limits ``aren't going to be credible unless we let somebody fail in a costly way that is beyond that scope,'' he said.